Europe’s Greek Miscalculation
In September 2008, US policymakers were caught flatfooted by the Lehman bankruptcy as they grossly miscalculated the fallout from that event. Today, European policymakers would seem to be making a similar miscalculation in the context of the fast moving Greek developments. First, they seem to be excluding the possibility that Greece could be forced out of the Euro. Second, they seem to be minimizing the cost of a Greek exit to the rest of the European economy were that to occur.
Despite the almost certain prospect now of a Syriza government, European policymakers appear sanguine about the possibility of a Greek exit. They largely base their optimism on the view that a Syriza government would have no interest in having Greece forced out of the Euro for fear of the domestic economic dislocation such an exit would cause. They also take the view that European policymakers do not have an interest in having Greece leave the Euro for fear of taking the Eurozone into totally unchartered waters. Since neither Syriza nor European policymakers wish to see Greece leave the Euro, the optimists reason that a deal will soon be forged between Syriza and the troika.
Were it all so simple. Plausible as the optimists’ argument might sound, it overlooks the very real constraints on both a Syriza government and the troika. After an election campaign promising large social spending increases and a tough negotiating line with the troika, it would seem highly implausible to think that Syriza can quickly make a large policy U-turn to satisfy the troika’s demands. Since doing that would risk losing total credibility with its political base and splitting an already divided political party.
For its part, the troika’s room for maneuver is limited by the fear of setting precedents for the rest of the Eurozone. If Greece is accorded a break from budget austerity and granted official debt relief, how can the troika withhold similar concessions to countries like Ireland, Italy, and Portugal? In addition, such concessions might make it difficult for northern governments to get their parliament’s approval for future Eurozone bailouts, especially after the ECB's recent move to full blooded quantitative easing.
These all too real constraints highly reduce the prospect that a quick deal can be reached. At a minimum, a new Syriza government will have to go through the time consuming motions of being tough in negotiation. For its part, the troika would need to have real reasons for making concessions that they were not prepared to make to the previous government.
The trouble with protracted troika negotiations is that Greece’s economy is in no position to withstand another few months of political uncertainty. There are already signs that Greece’s fragile economic recovery is being adversely impacted by uncertainty while its tax collections are plummeting. More troubling yet, there are clear indications that Greece’s bank depositors are already starting to draw down deposits.
Even more surprising than minimizing the chances of a Greek exit is the European policymakers’ downplaying of the fallout from such an event. For these policymakers seemed to have convinced themselves that the European economy now is in a better position to weather such an event than it was in 2012 and that it now has in place the financial safety nets to handle such an occurrence.
Among the most important of the risks being overlooked is that a Greek exit would send the clearest of messages to the Eurozone public that Euro membership was no longer irrevocable. More importantly, it would send the message to Eurozone bank depositors that they could no longer count on the ECB to always be there to act as a lender of last resort. That realization could provoke a run on the banks in countries like Italy, Portugal, and Ireland where public and private debt levels are now at very much higher levels than they were in 2012 and where these countries now find themselves caught in deflationary traps.
Another miscalculation that European policymakers might be making relates to the strength of the financial safety nets that they have put in place. To be sure, the Eurozone now does have a well-funded European Stability Mechanism and an ECB that is committed to buying as many of a member country’s bonds as might be needed. However, these mechanisms can only be activated should the countries being supported commit themselves to IMF-style economic adjustment programs. Considering the anti-austerity political backlash now characterizing these countries, it is far from clear that they would agree to submit themselves to the IMF’s tender mercies.
In light of the global economy’s unfortunate experience with the Lehman bankruptcy, one has to hope that European policymakers are only posturing with their threats to Greece ahead of its elections. Since if they are not, both the European and the global economies could be severely tested should Greece indeed be forced out of the Euro following those elections.